As a panic-fighting tool, then, OLA is at best unreliable. But are other tools not available? As detailed above, during the recent crisis the federal
126 Id. § 210(n)(5).
127 The debt ceiling needed to be increased in both of the major pieces of crisis-response legislation that were enacted in late 2008. See Housing and Economic Recovery Act of 2008, Pub. L. No. 110-289, § 3083, 122 Stat. 2654; Emergency Economic Stabilization Act of 2008, Pub. L. No. 110-343, § 122, 122 Stat. 3765. Former Treasury Secretary Henry Paulson has emphasized that the debt ceiling was a key issue in congressional negotiations during the crisis. See HENRY M. PAULSON, JR., ON THE BRINK 150, 154 (2009).
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government provided support on a going-concern basis to nearly the entire maturity-transformation industry. The goal was to avoid defaults not just on deposits but on money-claims more generally-to stop a broad panic in the money market. Conceptually, these support programs amounted to an exer- cise of lender-of-last-resort authority, broadly construed. Could these same kinds of techniques be implemented once again in the event of a future money market panic?
Again, the answer here is: not necessarily. The Dodd-Frank Act has imposed significant new limitations on the key panic-fighting tools that were used by the government during the recent crisis. To see how, it is useful to look again at the major programs that were used to stabilize the financial system in 2008 and 2009. As we have seen, the most important of these consisted of (i) a series of liquidity facilities established by the Federal Re- serve and (ii) massive guarantee programs that were rolled out by the FDIC and the Treasury Department. (Capital infusions were important too, but the focus for the moment will be on programs established pursuant to freestand- ing powers, i.e., programs that did not require mid-crisis congressional ac- tion.) These can be considered in turn.
Liquidity. Central bank lending has long been the standard first-re- sponse technique to quell financial panics. And the Federal Reserve lent lib- erally during the recent crisis, not just to regulated banks-the usual beneficiaries of so-called "discount window" access-but also to the unreg- ulated shadow banking system. In fact, Federal Reserve lending programs were deployed to support every major area of the money market: the dealer repo market (via the PDCF program), the commercial paper market (via the CPFF program), the asset-backed commercial paper market (via the AMLF program), the money market mutual fund industry (via the MMIFF pro- gram), and the Eurodollar market (via currency swaps with foreign central banks). Critically, massive Federal Reserve loans were also supplied on a targeted basis to prevent defaults by individual money-claim issuers ($30 billion to Bear Stearns and $85 billion to AIG, plus an undrawn nonrecourse loan commitment of $260 billion to Citigroup). The combined scale of these measures was awesome. At the peak of its lending, the Federal Reserve ex- tended over $1 trillion in loans to non-depositories. The legal authority for each of these facilities arose from the Federal Reserve's most potent weapon:
Section 13(3) of the Federal Reserve Act,28 which empowers the central bank to lend money to any firm-not just depositories-under "unusual and exigent" circumstances.
The Dodd-Frank Act has curtailed the Federal Reserve's 13(3) lending powers in two important ways. First, the Act imposes a new "broad-based eligibility" requirement on 13(3) lending.129 Tailored loans to individual non-banks are no longer allowed; 13(3) loans can now be extended only
128 12 U.S.C. § 343 (2006) (prior to Dodd-Frank Act amendments).
129 Dodd-Frank Act § I 101(a)(2).
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through programs to which a broad range of institutions may apply for sup- port. (Presumably the huge loan commitments to Bear Stearns, AIG, and Citigroup would have been off-limits; those controversial commitments were precisely the impetus behind this new limitation.) Second, the Dodd- Frank Act requires the Federal Reserve to obtain the prior approval of the Treasury Secretary before establishing any 13(3) lending program in the fu- ture.130 This new condition represents a significant departure from prior prac- tice. Before the Dodd-Frank Act, decisions to employ 13(3) lending powers were not subject to political constraints. Rather, they were left to the discre- tion of independent central banking authorities.
These two curtailments to the Federal Reserve's lending powers might in the end prove inconsequential. The Federal Reserve presumably could always decide to extend a loan to a particular, troubled institution under the guise of a "broad-based" program of general applicability. Likewise, the Treasury Secretary (at the behest of the President) might normally be ex- pected to defer to, or even encourage, the establishment of lending facilities by the Federal Reserve in times of financial stress. If so, then these new limitations on the Federal Reserve's 13(3) lending powers are just formali- ties-they will not make a difference in practice.
But is the answer so obvious? One can just as easily imagine the Fed- eral Reserve Board, under advice of counsel, being understandably disin- clined to sidestep (thwart?) the express intention of Congress by establishing a purportedly "broad-based" lending program whose real purpose was to prevent or delay the default of a particular, troubled institution. Any such hesitation can only be reinforced by the Dodd-Frank Act's explicit require- ment that the Federal Reserve establish by regulation "policies and proce- dures ... designed to ensure that any emergency lending program or facility is for the purpose of providing liquidity to the financial system, and not to aid a failing financial company ... "I3 Likewise, can it really be taken for granted that Treasury approval will always materialize in a timely fashion, or at all? The public has shown little enthusiasm for supporting distressed fi- nancial firms. (Imagine the headlines: "Administration Approves Massive Government Loans to Wall Street.") Public opinion might oppose interven- tion; the President might have publicly opposed "bailouts" in the past; polit- ical paralysis could take over. We must admit the possibility that the insertion of overtly political considerations into the lender-of-last-resort function could have a meaningful impact. Even if the effect is just to delay action, the consequences could be meaningful; in a panic, every hour counts.
Guarantees. One of the basic (and unnerving) lessons of the recent cri- sis was that central bank lending was not enough. An equally critical compo- nent of the federal government's emergency response-and the largest as measured by total dollars committed-consisted of a set of guarantee pro-
130 Dodd-Frank Act § I 101(a)(6).
131 Id.
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grams established by the FDIC and the Treasury Department. The FDIC guaranteed nearly $350 billion of new debt issuance by depositories and, more importantly, their holding companies. (By far the biggest users of this program were diversified financial institutions experiencing liquidity strains in their non-depository operations that relied on short-term funding.) The FDIC also guaranteed another $830 billion of previously uninsured noninter- est bearing transaction account liabilities. Finally, in the single largest dollar commitment of the crisis, the Treasury Department guaranteed over $3 tril- lion in money market mutual fund obligations-a dramatic and decisive measure that successfully stabilized the core of the shadow banking system.
Each of these guarantee programs was established solely on the basis of freestanding legal authorities, without the need for any new legislation. In the FDIC's case, the legal basis for its emergency guarantees arose from the so-called "systemic risk exception" to the normally applicable statutory lim- itations on the commitment of deposit insurance fund resources.32 (Invoking that exception required the assent of two-thirds of the boards of both the FDIC and the Federal Reserve, as well as the Treasury Secretary in consulta- tion with the President-but not congressional approval.) As for Treasury's money market fund guarantee, that program's statutory basis was a bit more imaginative. Treasury's guarantee facility made use of the Exchange Stabili- zation Fund, which was created in 1934 for the purpose of stabilizing the value of the U.S. dollar in foreign exchange markets.'33 As subsequently amended, the authorizing statute entitles the Treasury Secretary to use Ex- change Stabilization Fund resources to "deal in gold, foreign exchange, and other instruments of credit and securities" in a manner "[c]onsistent with the obligations of the Government in the International Monetary Fund on orderly exchange arrangements and a stable system of exchange rates."''3 4 The pertinent IMF obligations, in turn, include an undertaking by members to "seek to promote stability by fostering orderly underlying economic and financial conditions and a monetary system that does not tend to produce erratic disruptions."'13 5 Reasonable people might disagree as to whether these provisions furnished a sound legal foundation for the money market fund guarantee program-but Treasury's reading does appear to be at least in the range of plausible legal interpretations.
At any rate, the freestanding legal authorities that were used to set up these guarantee programs no longer exist. To implement any of the guarantee programs deployed in the recent crisis would require an act of Congress.
Specifically, under the Dodd-Frank Act, the FDIC's power to "create a widely available program to guarantee obligations of solvent [banks and bank holding companies] during times of severe economic distress" now
,32 Federal Deposit Insurance Act § 13(c)(4)(G), 12 U.S.C. § 1823(c)(4)(G) (2006).
'3 See Gold Reserve Act of 1934, Pub.L. No. 73-87, 48 Stat. 337.
13431 U.S.C. § 5302 (2006).
... Articles of Agreement of the International Monetary Fund, Article IV, Sec. 1, Dec. 27, 1945, 60 Stat. 1401, 2 U.N.T.S. 39 (emphasis added).
[Vol. I
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requires a congressional joint resolution of approval.'36 (For the avoidance of doubt: "Absent such approval, the [FDIC] shall issue no such guaran- tees."'37) Finally, Treasury's authority to guarantee the money market mutual fund industry-arguably the key turning point in the crisis-is gone. Con- gress took that authority away prior to the Dodd-Frank Act, in the Emer- gency Economic Stabilization Act of 2008 (EESA).138 But neither the Dodd- Frank Act itself nor any other post-EESA legislation has restored the capac- ity of any branch of government to mount a forceful response in the event of a run on this $3 trillion industry-the fulcrum of the shadow banking system.
"Shadow" Emergency Powers? Do these new restrictions on the gov- ernment's freestanding emergency response powers really matter? It was seen above that Treasury's guarantee of the money market mutual fund in- dustry in 2008 relied on what might be considered a rather expansive inter- pretation of its legal powers. Maybe Treasury officials, and their counterparts at the Federal Reserve and the FDIC, will always succeed in finding a colorable legal basis to stage an adequate and timely intervention in the event of a panic. Furthermore, Congress can always supply additional powers mid-crisis. That is what happened in 2008. One of the most visible aspects of the government's response to the recent crisis was the Treasury Department's infusion of equity capital-peaking at around $250 billion- into the largest U.S. financial institutions. (These infusions were sometimes advertised as a tool to induce lending, but their main purpose was to stabilize these institutions' short-term wholesale funding.) Treasury had nofreestand- ing authority to inject capital. Rather, Congress granted Treasury that power at the height of the crisis, through the (initially unsuccessful) passage of EESA.'39
So maybe the foregoing discussion of emergency powers is largely aca- demic. Indeed, one does occasionally hear the argument that these kinds of legal formalities do not matter-that the government will inevitably do whatever is necessary to rescue the financial system in the event of a panic.
A notable example of this line of thinking comes from economist Paul Krug- man, who recently wrote (the italics are his own):
[W]hen the next financial crisis arrives-well, it will play just like 2008. President Palin or whoever will find themselves staring into the abyss-and conclude that they have to bail out the finan- cial sector anyway. In a crisis, the financial system will be bailed out. That's just a fact of life. So what we have to do is regulate the
136 Dodd-Frank Act § I 105(c)(1).
137 Id.
'38 Emergency Economic Stabilization Act of 2008, Pub.L. No. 110-343, § 13 1(b), 122 Stat. 3765, 3797 (to be codified at 12 U.S.C. § 5236) ("The Secretary is prohibited from using the Exchange Stabilization Fund for the establishment of any future guaranty programs for the United States money market mutual fund industry.").
1391d. § 101, 122 Stat. 3767 (to be codified at 12 U.S.C. § 5211).
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system to reduce the chances of crisis and the taxpayer costs when the bailout occurs.140
If action by government officials or lawmakers is certain to materialize, then the suite of freestanding emergency powers is not particularly important.
Forcible action will always be forthcoming at the critical moment.
But how much faith should we have in this conclusion? Those who are inclined to think that legal constraints do not matter might do well to recon- sider the events of the recent crisis. One narrative account describes the mo- ment when Chairman Bernanke informed Treasury Secretary Paulson that the Federal Reserve had reached its legal limit:
"We cannot do this alone anymore," [Bernanke] said. "We have to go to Congress and get some authority." . . . Bemanke was growing agitated. "Hank! Listen to me," he interrupted. "We are done!" It was the first time Fed officials had heard him raise his voice. "The Fed is already doing all that it can with the powers we have," Bernanke continued. One participant recalled, "Ben gave an impassioned, linear, rigorous argument explaining the limits of our authority and the history of financial crises in the U.S. and abroad." 141
Perhaps it did not really happen this way. Or perhaps the Chairman's
"impassioned" argument was disingenuous-maybe he had a limitless sup- ply of legal tricks up his sleeve. But we should at least consider the possibil- ity that regulatory authorities will run up against hard legal constraints-and
4 Paul Krugman, Hijacking Too Big to Fail, THE CONSCIENCE OF A LIBERAL (blog) (Apr.
3, 2010, 12:11 PM) http:llkrugman.blogs.nytimes.com/2010/104/03hijacking-too-big-to-fail.
141 James B. Stewart, Eight Days, NEW YORKER, Sept. 21, 2009, at 59. Soon thereafter, Paulson agreed: "You and I should go see the President and then go to Congress tonight and ask for more authority." Id. The same message was delivered directly to the President:
In the Roosevelt Room meeting, Paulson reminded Bush that the Treasury secretary's authority to spend or lend money that Congress hadn't appropriated was extremely limited .... At one point, according to participants, Paulson made an oblique refer- ence to the possibility that the Fed could continue to finance the rescue of Wall Street if Congress balked. Someone-several participants recalled it was Bush, but others insisted it was Vice President Cheney or Chief of Staff Josh Bolton-pressed Bemanke. Could the Fed keep doing it if Congress was a problem? No, Bernanke said. He recited the limits of the Fed's legal authority even in "unusual and exigent circumstances."
WESSEL, supra note 81, at 202. Paulson tells a similar story:
"We've got a real problem," I said to the president. "It may be the time's come for us to go to Congress and get additional authorities." "Don't you have enough with the Fed? You just bailed out AIG," he pointed out. "No sir, we may not." . .. [In a White House meeting the following day] Ben insisted that, legally, there was noth- ing more that the Fed could do. The central bank had already strained its resources and pushed the limits of its powers .... President Bush pushed him, but he held firm. "We are past the point of what the Fed and Treasury can do on their own." Ben said.
PAULSON, supra note 127, at 242, 257.
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that they will abide by the law of the land. Every law student learns the shibboleth that law is inherently open-textured and flexible. But its flexibil- ity is not infinite; there are limits to plausible interpretation. The burden of persuasion here would seem to rest with those who for some reason doubt that legal constraints are binding in this area.14 Could any arm of govern- ment guarantee the money market mutual fund industry again if a panic erupted tomorrow? Cite a plausible legal authority. (The author is aware of none.) Could Treasury inject capital into the country's largest financial insti- tutions again? In 2008 the Administration thought it needed an act of Con- gress to take this step. No one has seriously argued otherwise. The assertion that authorities will always "find a way" is not particularly reassuring. Apart from being superficial and essentially conclusory, this line of argument raises troubling questions about democratic accountability and the rule of law.
Will Congress necessarily act promptly, or at all, once a crisis erupts?
The blithe assurance that it will-a fairly widespread (though far from uni- versal) sentiment, based on the author's unscientific polling-is perplexing.
Yes, they eventually acted during 2008. That is one data point. But it must be remembered that it is technically possible for the money market mutual fund industry and the broker-dealer industry, including broker-dealers housed within diversified bank holding companies, to exhaust their cash reserves and default within a day or two. Panics can erupt with blinding speed. Add to this the decidedly unpopular status of "bailouts" in our political dis- course, and the forces aligned against swift and decisive government inter- vention appear rather formidable. Relying on a mid-crisis act of Congress to furnish whatever tools are needed to keep the system from collapsing would seem to be a strategy fraught with peril. It is far from obvious that Congress will muster the political will to act before much of the damage is already done. (In 2008, the Federal Reserve's massive loan to AIG and Treasury's money market fund guarantee appeared to play a critical role in holding the system together between the Lehman Brothers bankruptcy (on September
142 The casual nature of legal argumentation in this area is sometimes surprising. Richard Posner, for example, has argued that the federal government's support for auto companies in December 2008 "undermined Bernanke's and Paulson's claim that they had lacked the legal authority to bail out Lehman. If they could lawfully bail out insolvent auto manufacturers, they could lawfully have bailed out an insolvent investment bank." POSNER supra note 57, at 277.
There is a problem with this legal argument: the statutory authority that was relied upon for the auto rescue did not yet exist when Lehman went bankrupt. (EESA, which created the TARP program that financed the auto rescue, was enacted on October 3, 2008---eighteen days after the Lehman bankruptcy on September 15.) So Posner's legal argument fails on purely formal grounds. If Posner's point was that employing the Federal Reserve's 13(3) lending powers to rescue Lehman would have been no more of a legal "stretch" than employing Treasury's EESA powers to support the autos-that the government was inconsistently permissive in its
legal interpretations-then that is an argument that might be made. But such an argument would require a careful examination of the relevant legal authorities; it cannot be made on the basis of logical implication alone.
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